EMC Q3 Earnings Review: Emerging Storage, VMware, Pivotal Drive Results

EMC (NYSE:EMC) announced its Q3 earnings on October 22, reporting record third quarter revenues of just over $6 billion. The company witnessed growth in both combined services revenues, which rose by almost 11% y-o-y to $2.6 billion. and consolidated product revenues, which rose by over 7% y-o-y to $3.4 billion for the quarter. All of EMC’s divisions  – including VMware, Pivotal, RSA Security, content management (or Information Intelligence Group) and core information storage – grew on an annual basis. EMC observed a rise in storage product revenues in the third quarter after two consecutive quarters of declines. Information storage products include both storage hardware and the integrated software within storage systems. ^[1]

EMC’s consolidated gross margin (GAAP) was down by 10 basis points annually to 62% in Q3, mainly as VMware’s gross margin declined by 2 percentage points y-o-y during the quarter to 86.5%. ^[1] Additionally, EMC’s non-GAAP operating margin was also about 30 basis points lower than the prior year quarter at 23.1%. Management expects full year revenues to be around $24.5 billion and non-GAAP operating margin to be around 24%.

See our full analysis for EMC’s stock

Emerging Storage Drives Core Business

In the first two quarters of 2014, EMC lost market share in the external storage systems market. This was the first time since 2008 that EMC lost market share on a y-o-y basis. EMC’s share in the external storage systems market was a percentage point lower than the prior year quarter at 30.1% in Q2. ^[2] More worrying for EMC was the fact that its decline in revenues (about 5%) was higher than the industry-wide decline (1-2%) in storage hardware sales. However, product sales have picked up in the third quarter with storage product revenues rising both sequentially (+2%) and annually (+7%) to $2.6 billion in Q3.

Growth was driven by the all-flash array XtremIO, software-defined storage platform ViPR, scale-out network attached storage platform Isilon and converged storage infrastructure ScaleIO, with XtremIO sales crossing the $500 million mark on an annualized run-rate basis during the quarter. ^[1] In line with our expectations, sales of emerging storage solutions including XtremIO, Isilon and Atmos grew at 47% year-on-year, with the contribution of emerging storage rising to over 60% of all high-end solutions provided by the company. The revenue contribution of emerging storage rose to $2.3 billion on an annualized revenue run-rate basis.

Pivotal, VMware and Stake in VCE

Pivotal was the fastest-growing division for EMC this quarter, with a 24% growth in net revenues to $58 million during the quarter. Although product sales were nearly flat over the prior year quarter, services revenues rose by over 50% to $41 million. The company attributed this rise to a higher number of subscription-based sales as compared to standalone licenses. The company plans to introduce new cloud and data fabrics technologies to build and deploy applications faster in the coming quarters, further driving growth of Pivotal Labs and Pivotal Cloud Foundry.

VMware’s revenues grew by over 17% year-on-year to $1.5 billion, with its services division driving much of the growth (see: Hybrid Cloud, Network Virtualization, End-User Computing Drive VMware’s Q3 Results). Management expects continued growth in software-defined networking, hybrid cloud and end-user computing, as evidenced by the its results through the first three quarters of 2014. VMware generates about 25% of EMC’s consolidated revenues, yet the highly-profitable business contributes about two-fifths to EMC’s net value, according to our estimates.

Immediately after its earnings release, the company announced that it will buy part of Cisco’s (NASDAQ:CSCO) stake in VCE – a joint venture of VMware, Cisco and EMC – for an undisclosed sum. Cisco previously had a 35% stake in VCE, which will decline to 10%. As a result EMC’s stake will go up from 58% to 83%. ^[3] VCE’s Vblock and related services combined had a sixth consecutive quarter of growth higher than 50% on an annual basis. EMC reported revenues of over $2 billion on annual run rate from Vblock and its related products and services. According to SDN Central, the software-defined networking market is set to grow at a CAGR of 80% from a $3.4 billion market at present to become a $35 billion market in 2018.

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1. EMC Q3 2014 Earnings Call Transcript, Seeking Alpha, October 2014 [↩] [↩] [↩]
2. Worldwide External Storage Market Q2 2014, IDC Press Release, September 2014 [↩]
3. The End Of Pretend? Cisco Looks Set To Partially Exit VCE Joint Venture, Forbes, October 2014 [↩]